An essay on the value of GDP

In recent years, the usage of GDP as a common indicator of living standards has come into contention, including by some prominent economists such as Joseph Stiglitz and Amartya Sen. Critics of GDP typically argue that GDP fails to provide a comprehensive representation of wellbeing and economic activity, does not sufficiently account for distributional concerns, and is itself a challenging metric to calculate – often subject to revisions. However, these arguments fail to recognise the significant value that a quantitative measure of living standards yields, especially in comparison to more subjective measures, nor recognise that many other factors that determine living standards are also highly correlated with GDP. Whilst GDP is certainly not a flawless metric, nor the only possible measure of living standards, the benefits of using GDP as an indicator of living standards outweighs its weaknesses substantially.

One particularly useful benefit of GDP is that it provides a quantitative measure of standards of living upon which comparisons can be made between other nations or time periods, in order to gauge a nation’s economic performance. Such a level of standardisation is remarkably beneficial as it reduces the extent to which subjective conclusions regarding comparisons between living standards between nations and time periods. Moreover, this metric can also be divided amongst the population (i.e. GDP per capita) or amongst hours of labour (labour productivity) to provide further measures of economic performance and living standards. Estimates of potential output (the maximum level of GDP growth that is sustainable in the long-run) can also be derived – allowing policymakers to correct short-run deviations from potential output using countercyclical fiscal and monetary stabilisation.

However, calculations of GDP are notoriously challenging and often inaccurate, as GDP is often subject to frequent and commonplace revisions. In an era where advanced economies are overwhelmingly service-based, this limitation will be amplified in future years. Likewise, not all production is incorporated into GDP; for instance, most advanced economies ignore the value of unpaid work in GDP calculations. As the burden of unpaid work in the household falls disproportionately on women, GDP is not a reliable indicator of gender inequality – a crucial aspect of living standards. Nevertheless, GDP can be amended to include unpaid work, and the process of calculating GDP can be improved in terms of accuracy, perhaps by relying more on hard data such as tax records and credit-card transactions as opposed to survey data. Indeed, in a digitalised society, the ability to collect hard data and reduce the level of error in GDP calculations is much easier and highly likely over time.

Critics of GDP as a standard metric of living standards often claim that a single measure of production does not incorporate all the factors, or the most important factors, that determine a country’s standard of living. Indeed, this argument has some merit; the level of employment in a country and average real wages are also important metrics with regards to gauging living standards. Likewise, the Stiglitz-Sen-Fitoussi Commission, convened by the French government in 2008, criticised the reliance of GDP as a measure of living standards on the grounds that GDP does not account for the overall health and education of the population, environmental quality, or the quality of family life and leisure. However, whilst it is possible to devise metrics that incorporate some of these factors (such as the OECD Better Life Index or the UN Human Development Index), questions regarding which measures to incorporate arise, thereby rendering the measurement of living standards as an increasingly qualitative (and subjective) exercise. It is inevitable that any measure of living standards is somewhat subjective, but the use of a single quantitative measure reduces this limitation and allows for more objective comparisons. Moreover, many of these other measures of living standards are correlated with GDP. For instance, a common feature of recessions (characterised by a sustained fall in GDP) is that unemployment rises, often rapidly as demonstrated in 2008, hence living standards fall. Labour porductivity growth is also widely regarded as a causal factor in determining real wage growth. Even the level of ‘environmental degradation’ falls once GDP growth continues beyond a certain level, as empirically documented using the ‘environmental Kuznets curve’.

Furthermore, GDP also fails to sufficiently account for distributional concerns. As GDP per capita is an average, those figures are often highly distorted by the incomes of the highest levels of the income distribution, therefore may not convey an accurate level of living standards experienced by the majority of the population. In this regard, median household income may be a superior representation of the standard of living that most of the population experience. For instance, whilst US GDP has grown substantially since the 1980s, this has been accompanied by a rapid surge in income inequality, and US median household income has (by some measures) been relatively stagnant since the 1980s. However, it can be argued that median household income is highly correlated with GDP. Indeed, whilst median household income increased in the US from after WWII until the 1980s, GDP growth throughout this period was faster than post-1980s. It is also important to note that US median household income did increase overall (alongside GDP) prior to the Great Recession in 2008, when both GDP and median household income collapsed. As such, this argument does not invalidate the use of GDP as a measure of living standards and economic performance, and as GDP can be used to derive measures of labour productivity and potential output (unlike median household income), this measure provides a broader measure of living standards.

Likewise, geographic inequality may also significantly distort GDP figures in a single nation, and often has the tendency to mask wide regional divergences in terms of economic performance. For example, according to Eurostat figures, nine of the ten poorest regions of Northern Europe are in the UK, as is the wealthiest region, despite the UK being one of the largest economies in Europe as measured by GDP. As such, overall UK GDP is not a sufficient representation of the living standards that many in the UK face. Nevertheless, this is rather an argument for a greater decentralisation of GDP figures rather than an argument against the usage of GDP itself when measuring standards of living.

Whilst GDP is certainly not a flawless metric nor the only possible measure of living standards, there is not a single measure in existence that conveys a perfectly comprehensive and accurate representation of living standards. In comparison with more qualitative measures, the usage of a prominent quantitative metric facilitates comparisons between nations and time periods, and many other factors that determine wellbeing are highly correlated with GDP. GDP itself can also be used to derive other measures of living standards, and whilst GDP is often subject to revisions and fails to account for all economic activity, the possibility of improvement in this aspect is high and probable over time. Overall, it is clear that the benefits of using GDP as an indicator of living standards outweighs its weaknesses substantially.